Burning the state's economy with higher tobacco taxes

By CHARLES M. ARLINGHAUS

Our disgust with smoking itself and our hatred of the great demon tobacco companies clouds our judgment and leads us to adopt tax increases that affect the people hurt most by a recession.
New Hampshire is on the verge of passing its fourth cigarette tax increase in the past five years. If the tax were levied on something other than cigarettes, it would be rejected.

Cigarettes are still a legal product and the source of much economic activity. It's not a matter of smokers buying directly from a manufacturer. For decades, New Hampshire has had a significantly lower cigarette tax than its neighboring states. The result is that many citizens from Maine, Vermont and Massachusetts make trips across the border to purchase cigarettes here.

It is generally assumed that roughly 40 percent of New Hampshire cigarette sales are to out-of-state customers. These customers are sensitive to tax changes. For example, when we raised taxes in 2005, our sales declined by about 7 million packs, while Massachusetts saw an increase of 8.5 million.

Our total loss was a little less because we gained at the expense of the much smaller Maine market. Economist Scott Moody studied the sales of a convenience store chain operating in both states. After Maine increased its tax by $1 per pack, the chain's stores in two Maine border counties saw decreases of between 7 and 10 percent, while its New Hampshire stores saw an 8 percent increase.

Cigarettes are a higher-margin item and out-of-state customers typically buy other goods as well. For small stores struggling in a difficult economic environment, driving away any customers is a problem. A significant loss in a higher-margin item could make the difference between survival and closing up shop.

Some policymakers believe that as long as our price is lower than the price in neighboring states, a tax hike will have little or no impact on sales. Our recent experience suggests instead that any tax increase has a psychological effect that translates into lower sales.

In the past, when Massachusetts raised taxes and we didn't, our sales increased, and vice versa. In 2008, Massachusetts raised its tax by a $1 per pack. We should have seen a significant windfall. But we also announced our intention to raise our tax by 25 cents. Although our tax would be still be $1 lower than theirs, that had a negative impact on sales.

Through the first eight months of this fiscal year, sales are about the same as they were last year. To be fair, with cigarette consumption declining a few percentage points each year, this is probably a slight increase in share but not nearly as much as we would have expected.

The psychological impact of any increase drives business away or creates a sense of equivalence in a consumer's mind.

Massachusetts will not be raising its tax this year, so any increase in our tax will likely lead to a significant sales loss for New Hampshire stores. This economic loss would ordinarily be problematic in a recession, but because the product is tobacco, normal rules are suspended.

The other major failure of cigarette taxes is that they are significantly regressive. Because people in lower-income levels are disproportionately more likely to smoke, they pay a significantly higher proportion of cigarette taxes. The Tax Foundation studied options for raising $35 billion at the federal level and "concluded that a cigarette tax increase hurts the poor more than virtually any other way of raising money to fund State Children's Health Insurance Program expansion."

The purpose of the proposed increase, like the three other increases in the last four years, is to raise money to fund the general purposes of government. To increase revenue exclusively through the most regressive option available is poor public policy.

The politicians most likely to support the cigarette tax hike are generally sensitive to the concerns about its harm to the poor and harm to small business, so why do they keep doing it?

The short answer is because it's smoking. Small increases in cigarette taxes do have a small effect in reducing the number of smokers. At least some subset of tax supporters would increase the tax $2 or $3 instead of 35 cents to try and make smoking unaffordable or more likely drive it underground.

More than a general anti-smoking attitude, it is paradoxically New Hampshire's anti-tax attitude that creates support for cigarette tax hikes. Many tax supporters will admit privately that they think raising the cigarette tax is bad policy, but they do it because they believe government needs more money and smokers are the path of least resistance.

Small businesses and poor people get caught in the crossfire, but they're just collateral damage.

Charles M. Arlinghaus is president of the Josiah Bartlett Center for Public Policy, a free-market think tank in Concord.